FOREIGN TRADE ZONES 101: PART 1

March 30, 2017

by Trey Boring

In this three-part blog series, Trey Boring, Senior Vice President of IMS Worldwide, Inc., presents an overview of the major issues companies must address to operate a compliant Foreign Trade Zone (FTZ). Boring is an expert in the field, and his firm is an internationally recognized authority on the establishment, marketing and operation of Foreign Trade Zones. In Part 1, Trey discusses key requirements, especially inventory control.

Let’s start with a fairly standard definition for a Foreign Trade Zone. If you’ve been around the program at all, you know that it’s an area within the geographic boundary of United States that has been approved by the U.S. Customs and Border Protection (CBP) as being outside its territory. That means that an FTZ is outside of the entry process for purposes of duty collection. Items can be brought into a foreign trade zone and manipulated via various approved activities. Customs duty is determined when that merchandise leaves this zone. Basically, in simplest terms, an FTZ resembles a preapproved business island within the United States.

With that definition in mind, let’s go over the basics of how a Foreign Trade Zone functions relative to inventory control, customs documentation and customs compliance.

Key Requirements

To operate a compliant FTZ, you must have an inventory control system that can tell you what merchandise is in your zone and the quantity. Customs is interested in knowing what’s there because you haven’t paid taxes on it – yet. In a sense, you’re holding CBP’s tax money, so they want to make sure you have a good accounting system.

The system also must track what is done to the merchandise. Obviously, you received it and shipped it, but how did you manipulate it? Did you simply retag the merchandise? Or, did you perform an activity that constitutes manufacturing or production within the Foreign Trade Zone definition? Did you manipulate the merchandise enough that it changed its status and/or changed its tariff classification? The inventory control system must track what you do with the merchandise no matter what activities you undertake in a Foreign Trade Zone.

Thus, the basic requirements of customs compliance are contained in the answers to some simple questions:

Can I explain to CBP what happened to my merchandise?

Can I track the sequence of merchandise coming into my facility, the activities performed and their exit from the facility?

And, can I show them that sequence in a format that they understand?

Another key item is customs documentation. We’ll talk later about the inbound and outbound documentation that is required for you to process.

Zone Activities

Many people ask: What activities are allowed in a Foreign Trade Zone? The answer is: Anything you do in your regular business facility can be done in a Foreign Trade Zone with the right approvals. Typical activities include distribution, storage, testing, repackaging, manufacturing, repair and assembly. The FTZ program is designed to be as free as possible to allow you to perform the operations that fit with the normal processes accomplished in your facility.

The question arises: If these are the normal processes you are already performing in your facility, why establish a Foreign Trade Zone? The answer takes us back to the definition of the FTZ program: It allows you to import merchandise without paying duty. Sure, all of these activities can be done in someone’s facility today but to do so you first pay duty at the port, the airport or the border crossing where the merchandise entered the United States. In a Foreign Trade Zone, you do not make that payment at the border, and what you do to the item while it is in your facility determines the actual duty amount paid. So, you get the benefit of duty deferral. You get the manipulation/manufacturing benefits (if you qualify to change the nature of a product). And, you can choose to apply the lowest duty rate for the imported item. So, the ability to manage duty and the entry process is the key reason why companies establish FTZs, not to mention the freedom the program accords companies to limit interference.

Inventory Control

So let’s talk about inventory control in a little more detail. Basically, we look for a stair-step method when talking about inventory control. So, starting at the beginning, zone admission refers to merchandise being admitted to the zone or the act of receiving goods into your zone facility.

Your inventory control process must capture the import documentation. Since you’re paying duty later in the process and not at the border, in order to close out the customs documentation you must have the import documentation provided on the admission document – the 214 – when filing to receive the goods. Further, you need a way to tell Customs “I checked the merchandise and the count is right” or “This is what I brought into the Zone and this is the variance.” You must have a physical accounting of that merchandise when it comes into your FTZ facility.

Also, you must perform a compliance review of the merchandise and the documentation. It goes to the point: Did I get everything I expected? Did the vendor send the wrong invoice? Are the products in the container listed on the invoice? Deviations happen, and you must identify them and offer a compliance solution.

Another important aspect is physical movement of merchandise. When dealing with inventory control, two things are important. First you must establish amount, value, tariff classification, Manufacturer Identification (MID) code, etc. – all of these data elements will be required later when you make entry, and your system must be able to generate them. Also, your system must be able to track where the merchandise goes because Customs wants to know what you have done with the merchandise since receipt.

The next focus is selecting your inventory methodology – cycle count or an annual inventory. Most companies select cycle counts. Basically, you must provide Customs a guarantee that you are counting that merchandise in your FTZ at least once a year. That’s the regulatory requirement. You can do that by shutting down your facility to perform an annual inventory where you can invite Customs to watch or you can perform continuous cycle counts and report variances as they occur. Either way, it is a critical element because you have to prove again to Customs that you can fully account for the merchandise that they have placed in your care without duty payment.

Common inventory control issues revolve around the data. Sometimes companies don’t have a good way to input their import documentation. Other problems involve value discrepancies. Then there are common warehouse issues such as someone on the dock didn’t count everything correctly and during the cycle count six weeks later you find you did not receive all of the expected 1,000 pieces. The other case is concealed shortages.

It is crucial, too, to analyze how your inventory control systems (e.g., warehouse management or manufacturing system) communicate with your FTZ software. Make sure these systems capture every transaction. Most compliance problems arise from systems that are not tracking everything. Then, you either reflect more inventory than you really have or less inventory than you’re supposed to have. So, the larger your zone – and more complicated the systems – the greater care you must exercise to assure the systems are interacting correctly.